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The market sentiment indicator

The S&P/ASX 200 VIX (A-VIX) is a real-time volatility index that provides investors, financial media, researchers and economists an insight into investor sentiment and expected levels of market volatility. The index tracks S&P/ASX 200 index option prices as a means of monitoring anticipated levels of near-term volatility in the Australian equity market.

Introduction - S&P/ASX 200 VIX and S&P/ASX 200

Since a volatility index at relatively high levels implies a market expectation of very large changes in the S&P/ASX 200 while a relatively low VIX value implies a market expectation of very little change, the S&P/ASX 200 VIX will often move inversely to the equity market. The following chart plots the S&P/ASX 200 VIX and the Australian equity market benchmark index, the S&P/ASX 200, over a eight year period from January 2008 to January 2016 and illustrates the inverse relationship between the two indices.

Uses and interpretation

The S&P/ASX 200 VIX is primarily used as an indicator of investor sentiment and market expectations. A volatility index at relatively high levels generally implies a market expectation of very large changes in the S&P/ASX 200 over the next 30 days, while a relatively low volatility index value generally implies a market expectation of very little change.

Similarly, when the volatility index is at relatively high levels and market expectation is for high levels of volatility, investor sentiment is perceived to be uncertain. Conversely, when the volatility index is at relatively low levels, market expectation is for low levels of volatility which implies greater levels of investor confidence.

Volatility indicators such as the S&P/ASX 200 VIX are often perceived to exhibit characteristics of mean reversion by oscillating around a long term average (or mean). In other words, a move away from the long term average towards high or low extremes is usually followed by a move back towards the long term average. The implication of mean reversion is that high levels of volatility are followed by a return to more normal levels of volatility and very low levels of volatility are often pre-cursors to an increase in volatility.

The S&P/ASX 200 VIX value is similar to rate of return volatility with the volatility index reported as an annualised standard deviation percentage that can be converted to a shorter time period. For instance, a volatility index value of 20% can be converted to a monthly figure remembering that volatility scales at the square root of time. The formula to do this is:

In the above example, index options over the S&P/ASX 200 are incorporating the potential for a one standard deviation return over the next month of +/- 5.77%.

Research